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European banks are paying pension funds and insurers to swap the banks' illiquid bonds for higher-quality securities to secure short-term funding from the European Central Bank. The swaps are happening because interbank lending has nearly ground to a halt because of the sovereign-debt crisis. The U.K. Financial Services Authority noted risks associated with the practice, but an industry group said points mentioned by the regulator are not insurmountable.

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Sovereign-debt investors shifted out of safe-haven German bonds and starting buying the debt of southern European countries after hearing reports that the European Central Bank might buy corporate bonds to stimulate growth. Yields fell for bonds issued by Italy, Greece, Spain and Portugal.

The European Central Bank has preferred-creditor status in the Greek bond swap. The situation could undermine the ECB's effort to shore up Portugal and other weak sovereign-debt issuers. "The ECB's position as assumed preferred creditor ... makes its bond-buying program less effective at holding yields down, because the more the ECB's holdings increase, the greater the risk that the remaining private-sector holders are pummeled in any eventual restructuring," said Simon Smith, chief economist at FxPro.

The European sovereign-debt crisis has caused much concern among policymakers, investors and other interested parties. Banks that hedged their bets using credit default swaps are trying to determine the reliability of their counterparties. "When there is a high degree of correlation between the underlying risk and that of the hedge counterparty [in this case, the sovereign and a bank selling CDS], can you rely on a payment from your protection seller?" said Joyce Frost, partner at derivatives consultancy Riverside Risk Advisors.

Leaders from the EU are poised to gather at a summit in Brussels this week to discuss the idea of establishing a permanent debt-crisis mechanism to help countries that become overindebted. Officials also will consider overhauling the rescue fund to use it to buy bonds of struggling nations. They also will address investor concerns about the EU's preparedness to curb the sovereign-debt crisis. Meanwhile, officials at the European Central Bank will be working on a plan to help struggling lenders. If the debt crisis continues to spread, the ECB might be forced to ramp up its bond-buying program.

The Federal Reserve will begin providing U.S. dollars to central banks in Europe to prevent the spread of the continent's sovereign-debt crisis. Restarting the emergency currency-swap tool will allow the European Central Bank, the Swiss central bank and the Bank of England to provide dollars to markets as needed.